CHICAGO–(BUSINESS WIRE)–lt;a href=”https://twitter.com/hashtag/BDO?src=hash” target=”_blank”gt;#BDOlt;/agt;–Navigating trade tensions and tax reform, heightened competition for new
deals and preparations for an impending market correction are the top
issues facing private equity fund managers, according to BDO’s
Tenth Annual Private Equity PErspective Survey. In fact, 89 percent
of private equity fund managers expect a prolonged downturn sometime in
the next two years. Over one-fifth (22 percent) anticipate a market
correction in the next 6-12 months. Meanwhile, more than two-thirds (67
percent) anticipate a market correction in the next 1-2 years.

Whether the next recession comes tomorrow or in two years, private
equity firms are proactively taking steps to shore up their portfolios
for potential economic headwinds. To prepare for a downturn, 70 percent
of survey respondents are being more selective when evaluating highly
valued deals, although strong deal activity indicates that investors are
still eager to deploy capital. Concurrently, 14 percent are holding
their current investments for longer periods, and just 8 percent are
exiting current investments.

“Data suggests that there’s a shift underway in private equity, with
valuations at historic highs and competition for a limited number of
quality deals driving up purchase prices,” said Scott
Hendon, National Private Equity Industry Group Leader at BDO. “A
confluence of economic factors leads us to believe a market correction
may be coming and to expect valuations to be tested as buyers get less
aggressive on cyclical assets.”

In a competitive environment, dependable sources of deal flow are more
vital than ever before. Private company sales/capital raises are the
most cited drivers of deal flow in the next 12 months, noted by almost
two-thirds of respondents (61 percent)—a seven percentage point decrease
from last year but up substantially from the year prior. PE exits are
the second-most-cited at 21 percent, relatively consistent with
projections from the past two years.

Competition for new deals in middle market private equity is getting
significantly tougher. Over the next 12 months, survey respondents said
the most competition for middle market deals will come from other
private equity firms (83 percent), followed by strategics (11 percent),
surprisingly lower than expected. While strategic buyers continue to bid
up prices, middle market PE peers are multiplying and, at the same time,
bulge-bracket PE firms are moving downward.

Over the next 12 months, the overwhelming majority (89 percent) of firms
will direct the most capital toward new deals, putting on the backburner
add-on acquisitions and de-leveraging portfolio company balance sheets.
Funding portfolio working capital needs is also not a top priority
compared to the hunt for new deals.

Views on the Trump Administration’s Policies: Forty-five
percent of survey respondents say the policies of the Trump
administration are likely to increase investor interest in private
capital. Twenty-two percent expect exit multiples and the environment
to decline due to the Trump administration’s policies, compared to 18
percent anticipating the opposite.

Trade Tensions Are the Biggest Political Concern: Reflecting
the major impact of tariffs and the proposed agreement to replace
NAFTA, trade is overwhelmingly (50 percent) the biggest concern among
global political issues for private equity fund managers. Trailing far
behind is the U.S. presidential administration (18 percent) and Brexit
uncertainty (12 percent).

Top Regulatory Concerns: This year, tax reform is private
equity firms’ chief regulatory concern, cited by 21 percent of survey
respondents. The Affordable Care Act also ranks high on the list of
regulatory concerns, selected by 20 percent of the PE fund managers
surveyed. The pressure to retain talent with competitive healthcare
programs and the political uncertainty around mandatory benefits
coverage by employers are also dominating the regulatory landscape for
PE executives.

Industry Outlook: Healthcare & biotech (22 percent) and tech
(24 percent) are the middle-market sectors most likely to experience
increasing deal activity during the next 12 months, according to
survey respondents. Retail & distribution (20 percent) and real estate
(19 percent) are the middle-market sectors most likely to experience
decreasingly deal activity during the next 12 months.

Uses of Proceeds from Debt: Other than to fund acquisitions,
nearly a third of survey respondents said they’re using proceeds from
debt towards dividend recaps (30 percent). However, fewer are opting
to improve the balance sheet by refinancing debt (14 percent) or
investing in operational improvements (17 percent). Fifteen percent
are not planning to increase any of their portfolio’s leverage. Just
under one-quarter of survey respondents (23 percent) say they’re using
proceeds from debt to fund add-on acquisitions.

Understanding Evolving GP/LP Dynamics: To improve their
relationships with LPs, most respondents report taking steps to
improve reporting transparency and fee disclosures (44 percent) or
offering alternative investment structures such as co-investments or
separate managed accounts (40 percent). Fund managers believe the
management team (20 percent) and track record (29 percent) are the
most important factors for LPs when evaluating GPs in today’s
environment. Operating experience (13 percent) and investment focus
(11 percent) are also believed to be important, but slightly less so.

International Investment Remains Strong: Outside of North
America, continental Europe is considered the most attractive region
for investment (45 percent) in the next 12 months, with Asia coming in
second (27 percent). South and Central America follows at 14 percent,
with Eastern Europe (9 percent) and the Middle East and Africa (5
percent) trailing behind as key regions for investment in the next
year.

The BDO Tenth Annual Private Equity PErspective Survey is
an international survey of more than 75 senior executives at private
equity firms in the U.S. and internationally. The survey is administered
by PitchBook, an independent and impartial research firm dedicated to
providing premium data, news and analysis to the private equity industry.

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